Wednesday, 11 July 2012

Learn To Invest - The Balance Sheet

Any investment in shares should be made based on understanding of the business in which the company is involved, its sales turnover, the projected business growth etc.  and should never be based on empty hype. But how to learn more about the financials of a company?

One of the important tools that the investor can use to glance at the financials of a company is the company’s balance sheet.
Knowing how to read the balance sheet is an important part of learning to invest in stocks.

Balance sheet is like a window into the financial status of the company and a lot can be known by studying the balance sheet. Also, the balance sheet is publicly available for any listed company either on the respective company website or on sites like Moneycontrol and many others. The balance sheet contains the basic information of assets and liabilities and whether there is any net worth/net asset by way of earnings after covering for the expenses. But the information is in so many technical terms that we need to interpret it correctly.

In this post as well as a few future posts we will try to learn about this vital information source of the company and how we can use the balance sheet while making investments in stocks.

In general we can say that the company balance sheet contains information about its assets and liabilities. The liabilities should be less than the assets for a properly functioning company. There can be another perspective to this. Sometimes companies can take some debt to fund their business and expand the business further. This may reflect as a good amount of debt in the balance sheet. But if the company is able to finance the interest and principal payment on the debt from its earnings and reserve funds then it is well and good. How well is a company able to do that, can be deducted from the balance sheet.

Some of the parameters which can give us an indication about the financial strength of the company and are reflected in the balance sheet are debt/equity ratio,working capital, total asset,total liability,current asset,current liability,book value, return on asset (ROA) etc. A simple table which gives an idea of what constitutes assets and liabilities is given below.

Assets and Liabilities

We will cover these and some other important aspects in future posts. This should help us learn about the companies better before investing in the stocks. You can visit the section on Learn to Invest to know more.